Developing Share Lease Agreements for Farmland by kuf92497


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									                Oklahoma Cooperative Extension Service                                                               AGEC-215

                                        Developing Share Lease
                                        Agreements for Farmland

Damona G. Doye                                                            Oklahoma Cooperative Extension Fact Sheets
Extension Economist
                                                                              are also available on our website at:
Randy True
Extension Assistant
                                                                     2.    Adjust share arrangements to reflect the impact on costs
   Not all producers can afford to own all the land they cultivate         and returns of new technologies adopted. For example,
or pasture, and others prefer the financial flexibility of renting         suppose the use of a new herbicide eliminates the need
land. Likewise, some landowners prefer not to operate a farm,              for most of the tillage presently performed by the tenant
but wish to earn an annual cash return on their land investment.           and will increase yields. The cost of the herbicide should
A lease agreement can be the common ground upon which                      not be totally borne by the tenant because the landlord
tenants and landowners meet. Five important considerations                 will also benefit from increased yields. Parties to the lease
in developing a lease agreement are:                                       should estimate the yield benefit they will receive and the
1. What portion of income do I receive?                                    savings the tenant will realize from reduced tillage and
2. What portion of costs do I contribute?                                  adjust their contributions accordingly. The appropriate
3. What portion of the risk do I bear?                                     landlord and tenant share is set by determining the net
4. What crop and land management practices will be                         benefit to each party resulting from the herbicide adop-
     followed?                                                             tion.
5. What will be the condition of the land after the term of the      3.    Share total returns in the same proportion as total
     lease?                                                                expenses are contributed (including values for land
                                                                           and management). Subtle differences in the quality of
     Landowners and tenants may choose from various types of               resources can greatly affect the value of the resources
lease arrangements: fixed or flexible cash rents, crop share,              and can have large effects on return. For example, a
or some combination. The purpose of this fact sheet is to                  tenant’s operating costs may be essentially the same
help tenants and landowners develop fair crop share rental                 on poor land as on good land. Thus, the landowner’s
arrangements. The crop share lease requires joint decisions                fair share of the crop may increase on more productive
and detailed negotiations between the landlords and tenants.               land. Share estimates should be examined and adjusted
     Crop share arrangements are used primarily with cash                  regularly to account for changes in value or costs.
crops such as wheat, cotton, peanuts, and soybeans although          4.    Compensate tenant and/or landlord at the end of the
share arrangements may also be used with forage crops and                  lease for the unused portion of longer-term investments.
pasture. Because the crop share lease involves the sharing                 For instance, if a tenant shares the cost of large fertil-
of both expenses and income by tenants and landlords, it can               izer applications to build up low-fertility soils, prorate the
be more difficult to develop than the cash lease arrangement.              cost over several years. If the lease terminates before
The lease parties must decide how to share expenses such                   the costs are prorated, the landlord should compensate
as fertilizer, seed, lime, chemicals for weed and insect control,          the tenant accordingly. If compensation arrangements
custom work, and harvest costs. They must jointly decide on                cannot be made, then the person who will likely control
tillage practices, crop rotations, participation in government             the investment at the end of the lease should make the
programs, appropriate rent for livestock facilities, and who               contribution. For improvements that can not be moved,
pays for improvements.                                                     the landlord will be in control.
     Crop share leases vary from area to area. Because no two        5.    Communicate regularly, and as needed when circum-
farming operations are exactly alike, lease agreements are                 stances are changing. Good landlord-tenant communica-
custom tailored to fit the operator and landlord. Some recom-              tions will cover up a multitude of economic sins and will
mended crop share leasing practices are:                                   reduce areas of ambiguity and conflict. Communication
                                                                           can help maintain economic efficiency and equity in the
1.   Share variable expenses that are yield-increasing in the              leasing arrangement by keeping the parties informed of
     same percentage as the crop is shared. This encourages                new or different needs.
     optimal resource use. Yield-increasing variable expenses
     include fertilizer, herbicides, insecticides, etc. An ar-
     rangement where the tenant provides all of the fertilizer,      Valuing Contributions
     but receives only half the crop encourages lower-than-               An equitable agreement can be developed in two steps:
     optimum fertilizer use.                                         1.    Determine the percent of total value of fixed items con-
                                                                           tributed by each party.

Division of Agricultural Sciences and Natural Resources                                  •    Oklahoma State University
2.   Share the variable costs and returns in the same percent-       while interest, depreciation, taxes, and insurance on irrigation
     age as the parties share fixed costs.                           equipment are included in the equipment contribution.
                                                                         Management contributions are largely a bargaining point
    Alternative arrangements may be negotiated if the parties        between the two parties. Some experienced landowners share
want to share the variable costs and returns differently. A          management responsibilities, while others are not involved in
worksheet to assist you in identifying and valuing contributions     management. The value of management can be determined
is shown in Figure 1 and an example is shown in Figure 2. A          in several ways. One method is to use a percentage (2.5 per-
discussion of items in the worksheet follows.                        cent is common) of the average value of total capital invested
                                                                     (the fair market of value of land plus the average value of
                                                                     machinery and equipment). Or, you may use a percentage
Fixed Costs                                                          of gross farm receipts (5-8 percent is common).
    Land quality and prices vary from area to area and deciding          Labor rates paid to most farm employees in the community
on an objective method of determining an annual land charge          should be used in estimating labor expenses. This rate may
or return on investment is difficult. First, determine the current   be adjusted upward in valuing the operator’s unpaid labor as
value of the land when used for agricultural purposes. The           the operator’s labor is generally more valuable than the labor
actual cost, current market value of land, or any value of land      of an average employee.
for development purposes is irrelevant in this context. Next,            After total fixed costs and the relative contributions of tenant
determine an annual charge based on some percentage of               and landlord have been estimated for each item, the percent-
the land’s value, which is approximately the long-run return         age of total fixed costs paid by the tenant and landlord can be
to the farmland. Several acceptable means of determining a           calculated. The tenant and landlord must then decide whether
long run return or capitalization rate are:                          to share variable costs and income in the same percentage
1. Use a “safe” rate, such as the rate offered on government         or develop an alternative arrangement.
     securities or certificates of deposit, plus a risk premium          If individuals do not want to share the cost of all variable
     (1-2 percent) for added risk minus any expected annual          inputs in the proportion indicated by fixed cost contributions,
     percentage increase in land value or add any expected           income shares can be based on total fixed and variable cost
     annual percentage decrease in value. This rate will likely      contributions. Parties to the agreement then share receipts
     be higher than the rate from the following two procedures.      in the same percentage that they contribute to total fixed
2. Divide the annual cash rent common in your area for               and variable costs. Or, if the parties prefer a specific share
     similar quality land by the per acre agricultural value of      of receipts (for example, 2/3-1/3), the individual’s purchase
     the land.                                                       of variable inputs may be adjusted until the desired percent-
3. List estimated expenses (both cash and non-cash) and              ages of contribution are reached. Use items such as seed
     income for crops on the land and calculate the per acre         and harvest expenses to initially adjust shares and use yield
     net income. Then divide the net income per acre figure          affecting items such as fertilizer only if further adjustment is
     by the per acre agricultural land value.                        needed.
                                                                         Several common situations may result in a need to look
    Buildings and other improvements should be evaluated             beyond fixed costs to determine shares:
on the basis of their contribution to the farm operation. It may     1. An elderly landowner may not want to share cash costs
be best to separate improvements from land value and evalu-                of all variable inputs.
ate their contribution separately. Old chicken houses or a new       2. Individuals may prefer to follow certain norms in an area,
machine shed are of little value to an operator who does not               which dictate that a landowner shares only certain costs
use them. On the other hand, the added convenience of a                    (for example, fertilizer and chemical costs).
farm shop close by for necessary repairs may be valuable.            3. The individuals may prefer a different end result in terms
If supplemental cash rent is charged for improvements, the                 of share, for instance, a 2/3 and 1/3 arrangement (67
improvements should not be part of the contribution calcula-               percent and 33 percent) rather than the 45-55 or 50-50
tion.                                                                      share (for example) arrangement indicated by the value
    Fixed equipment and machinery contribution estimates                   of fixed contributions.
should include costs of interest on the investment, deprecia-        4. To the extent that chemicals or equipment are a substitute
tion, taxes, and insurance. Again, the interest factor should              for labor, their cost may be borne by the person providing
represent a fair return on average investment and not neces-               the labor.
sarily the mortgage rate. If the tenant farms other land (either
leased or owned), the equipment and machinery fixed costs               If a single crop agreement is preferred to a whole farm
should be allocated over all land rather than a single leased        agreement, costs should reflect averages in proportion to the
property.                                                            amount of acres of the specific crop in the agreement. The
    Irrigation represents a substantial part of the investment       value of any additional pasture, building, and other improve-
in some operations. Generally, the value of wells and estab-         ments should also be noted in a whole farm plan.
lished underground pipe are included in the land contribution

Figure 1. Crop-share lease worksheet.

                                                        Annual Costs              Landlord Costs          Tenant Costs
              Return on investment1
              Real estate taxes
      Building & other improvements
              Taxes & insurance
      Equipment & machinery
              Taxes & insurance
      Conservation measures
Total fixed costs
Percent of total fixed costs
VARIABLE COSTS (for 160 acres)
      Fuel, lube, & repairs: Equipment
      Fuel, lube, & repairs: Irrigation
      Crop insurance
      Custom work
      Harvest costs
              Custom harvest
              Custom haul
      Operating interest
Total variable costs
Total costs
      Percent of total costs

                           (Total annual cost     x     Desired share)     -    Party’s current    =     Dollar value of
                                                                                 total costs           adjustment needed
      Landlord:                                   x                        -                       =
      Tenant:                                     x                        -                       =

      Adjustment item:                                                             Landlord                Tenant

      Dollar value of adjustments
      Adjusted total (total costs +/-adjusted items)
      Party’s adjusted contribution (%)

Return on investment (ROI) = capitalization rate x per acre value of land x acres of land.

Sample Worksheet                                                                                       Whole Farm          Leased Land
                                                                                                       Fixed Costs         Share (1/4)
    Figure 2 illustrates use of the lease worksheet for a quarter
section of land (160 acres) valued at $900 per acre2 used
                                                                          ($90,000 - $10,000)/8           $10,000              $2,500
primarily for dryland wheat production. Grain yield is expected
                                                                          Interest: ($90,000
to be 30 bushels per acre. There are no improvements on the
                                                                            + 10,000)/ 2 x 6%               3,000                 750
land of value to the tenant. Cash rent for comparable land in the
                                                                          Taxes & insurance              ____400              ___100
area is $33/acre. The operator has $90,000 of used machinery
                                                                          Total                           $13,400              $3,350
and equipment with an average expected life of 8 years and a
total salvage value of $10,000. The equipment consists of a 140           Management
hp tractor and various implements. The operator farms three
additional quarter sections of land (480 acres) outside of this              Two alternatives for estimating management contributions
agreement; thus one-fourth of the machinery and equipment                 are:
expenses will be charged to this lease. The operator supplies
100 hours of labor valued at $10 per hour and a hired hand                a. Percentage of average capital invested:
supplies another 100 hours of labor valued at $9 per hour.                   Landlord:     $900/a x 160 a x 2.5% =      $3,600
Calculations for valuing fixed contributions follow.                         Tenant:        $3,350 x 2.5% =              83.75
                                                                             Total management contribution           $3,683.75
                                                                          b. Percentage of gross farm receipts (excluding government
  Three alternatives for determining the capitalization rate
used to estimate an annual land charge are:
                                                                             Total management contribution =
                                                                                        $212.00/a x 160 a x 6.5% = $2,204.80
a. Safe rate: Interest rate on certificate of deposit + risk pre-
   mium - appreciation in land value =
                                                                             In Figure 2, the tenant and landlord share management
                                    2% + 1% - 1% = 2%.
                                                                          responsibilities equally and are each allocated 50 percent
b. Cash rent value divided by land value per acre =
                                                                          of the $2,205 estimated contribution based on gross farm
                                 $33/a ÷ $900/a = 3.7%
c. Estimated returns per acre:
      Grain receipts = 30 bu/a x $6.00/bu = $180.00                       Adjusting Total Shares
      Wheat pasture revenue                       $32.00
      Gross receipts                             $212.00                     The percent of total fixed costs contributed by the landlord
      Government payments3                         $ —                    and tenant is 53 and 47, respectively. The landlord and ten-
      Total returns                              $212.00                  ant wish to have an agreement close to 1/3 and 2/3 (or 33
                                                                          and 67 percent) arrangement with the tenant covering most
    Estimated total production cost except                                variable costs. Initially, the landowner plans to pay 1/3 of the
       return on land ($/a):                          $198.10             costs of chemicals, fertilizer, and fertilizer application costs,
                                                                          as is tradition in the area. Preliminary estimates of planned
    Estimated per acre profit:                                            contributions to fixed and variable costs indicate total shares
       total returns – total costs =                                      of 20% and 80%, rather than the desired 33% and 67%.
                           $212.00 - $198.10 = $13.90/a                      The first step in adjusting contributions is to determine the
                                                                          dollar amount of change necessary to achieve the desired
    Estimated capitalization rate:        $13.90/$900=1.5%                shares. The formula for determining the dollar value of adjust-
                                                                          ment needed is:
   The annual land charge or return to investment equals
the capitalization rate times the per acre value of land times               Adjustment = (Total annual cost x desired share) – party’s
the number of acres of land. The capitalization rate is entirely          current total costs
negotiable and any one of the three can be used or the three
can simply be used to establish a reasonable range for an                      Landlord:   ($35,474 x 33%) - $7,153 = $4,672
acceptable rate. In our example, the annual land charge uses                   Tenant:     ($35,474 x 67%) - $28,321 = ($4,672)
2.4%, an average of the three estimated capitalization rates:
2.4% x $900/a x 160 a = $3,456.                                               Next determine which variable cost items to adjust. Keep
                                                                          in mind the principle of sharing the cost of yield-affecting
Equipment and machinery                                                   inputs in the same percentage as receipts are divided. In this
                                                                          example, most yield-increasing inputs are already shared.
    Using the straight line depreciation method, depreciation =
                                                                          Here, costs can be adjusted by approximately $5,000 if the
(value of equipment and machinery – salvage value) ÷ years
                                                                          landowner is assigned one-third of the seed, fuel, lube, re-
of life.
                                                                          pairs, and custom harvest costs. This adjustment is sufficient
    A great source of information to assist in determining the value
                                                                          to change the overall share of costs to approximately 33% to
    of the acreage is the Oklahoma agricultural land values website
    ( Information displayed is based
                                                                          the landowner and 67% to the operator.
    on actual land sale data. The website has information on cropland
    and pasture values by county, region, state, and by size of tract.
    Government program payment amount will vary, depending on
    which commodity program is chosen.

Figure 2. Crop-share lease worksheet example.

                                                         Annual Costs           Landlord Costs          Tenant Costs
              Return on investment                         $3,456                 $3,456
              Real estate taxes ($2/a)                        320                    320
      Building & other improvements
              Taxes & insurance
      Equipment & machinery
              Interest                                         750                                           750
              Depreciation                                   2,500                                         2,500
              Taxes & insurance                                100                                           100
      Conservation measures
Total fixed costs                                            7,126                 3,776                   3,350
Percent of total fixed costs                                 100%                   53%                     47%
VARIABLE COSTS (for 160 acres)
      Seed (2 bu/a x $16.00/bu)                              5,120                                         5,120
      Fertilizer ($24.00/a)                                  5,440                 1,812                   3,628
      Chemicals ($4.70/a)                                      752                   250                     502
      Fuel, lube, & repairs: Equipment ($44.80/a)            7,168                                         7,168
      Fuel, lube, & repairs: Irrigation
      Crop insurance ($7.00/a)                               1,120                                         1,120
      Custom work (fertilizer application at $4.00/a)          640                   213                     427
      Harvest costs
              Custom harvest ($16/a + $.16/bu > 20 bu)       2,816                                         2,816
              Custom haul ($.16/bu x 30 bu)                    768                                           768
      Operating interest                                       420                                           420
      Management                                             2,204                 1,102                   1,102
              Unpaid (100 hrs x $10/hr)                      1,000                                         1,000
              Hired (100 hrs x $9/hr)                          900                                           900
Total variable costs                                       28,348                  3,377                  24,971
Total costs                                                35,474                  7,153                  28,321
      Percent of total costs                                100%                    20%                     80%

                            (Total annual cost     x     Desired share)   -   Party’s current    =     Dollar value of
                                                                               total costs           adjustment needed
      Landlord                 ($35,474            x         33%)         -       $7,153         =         $4,972
      Tenant:                  ($35,474            x         67%)         -     $28,321          =        -$4,672

 Adjustment item:                                                               Landlord                  Tenant
     1/3 seed                                                                    $1,707                 ($1,707)
     1/3 fuel, lube, and repairs                                                  2,389                  (2,389)
     1/3 custom harvesting                                                          939                    (939)

      Dollar value of adjustments                                                $5,035                 ($5,035)
      Adjusted total (total costs +/- adjusted items)                           $12,188                 $23,286
Party’s adjusted contribution (%)                                                  34%                      66%

Putting Your Agreement in Writing                                     •	 The	terms,	signatures,	and	acknowledgements	of	landlord	
   Once a tenant and landowner have decided on an equitable              and tenant
agreement, it should be put in writing. Some of the advantages        •	 Signatures	 of	 witnesses	 and/or	 acknowledgement	 of	
of a written agreement are:                                              recording may also be required
1. It emphasizes details and assures a better understanding
     by both parties.                                               Summary
2. Later, it serves as a reminder of the terms originally agreed       Developing an equitable crop share lease agreement
     upon and is valuable when the agreement needs to be            requires both the tenant and landlord to provide estimates of
     evaluated and/or reviewed.                                     their contributions to production costs (both fixed and variable
3. It provides a valuable guide for the heirs if either the         expenses). Use of area standards or traditions may not be in the
     tenant or landlord dies.                                       best interest of either party. The crop share lease worksheet
                                                                    can be a helpful tool in drafting an equitable agreement.
   In addition to the payment or crop share, every lease should
include certain items:
                                                                    Other OSU publications of interest
 •	 Names	and	addresses	of	the	parties	involved	                      •	 AGEC-198,	Negotiation	Strategies
 •		 Date	 when	 the	 lease	 is	 made,	 becomes	 effective	 and	      •	 AGEC-214,	Developing	Cash	Lease	Agreements	for	Farm-
     ends                                                                land
 •	 A	legal	description	of	the	property	                              •	 CR-216,	Oklahoma	Pasture	Rental	Rates
 •	 Number	of	acres	                                                  •	 CR-230,	Oklahoma	Cropland	Rental	Rates
 •	 Conditions	for	terminating	the	lease	
 •	 Rental	 arrangements	 (who	 pays	 for	 what	 input,	 how	       To access these fact sheets on the web, go to osufacts.okstate.
     income is shared, who makes decisions, what will be            edu. You may search by fact sheet number in the search bar
     provided by each party with respect to machinery, equip-       at the top right of the front page.
     ment, labor, and other inputs)
 •	 A	plan	to	pay	property	taxes,	repairs,	and	insurance	on	
                                                                    Publications of interest are also avail-
 •	 Crop	insurance	                                                 able from Midwest Plan Service at www.
 •	 Use	 of	 premises,	 including	 farming/ranching	 practices	
     and how the property will be maintained (soil pH, fertility,
     stocking rate, etc.)                                               Some lease forms are free. Click on Free Materials, Free
 •	 Compliance	with	FSA,	NRCS,	and	other	governmental	              Lease Forms.
     agency requirements                                             •	 NCR-75,	Fixed	and	Flexible	Cash	Rental	Arrangements	
 •	 Terms	for	reimbursing	tenant	for	capital	improvements	              for your Farm
 •	 Records	to	be	kept	                                              •	 NCR-76,	Cash	Farm	Lease	(with	Flexible	Provisions)	Form
 •	 Insurance	(or	hold	harmless	clause)	                             •	 NCR-77,	Crop-Share	or	Crop-share/cash	Farm	Lease	
 •	 Repercussions	of	failure	to	pay	rent	                               Form
 •	 Damages	                                                         •	 NCR-105,	 Crop-share	 or	 Crop-share/Cash	 Rental	Ar-
 •	 Subletting	                                                         rangements for your Farm
 •	 Mineral	rights	                                                  •	 NCR-106,	 Irrigation	 Crop-share	 or	 Crop-share/Cash	
 •	 Payment	arrangements	and	assurances	                                Farm Lease Form
 •	 Any	reservations	of	rights	by	the	landlord	(entry,	hunting	      •	 NCR-109,	Pasture	Lease	Form
     and fishing, pecan harvesting, etc.)                            •	 NCR-148,	 Irrigation	 Crop-share	 and	 Cash	 Rental	 Ar-
 •	 Arbitration	                                                        rangements for your Farm
 •	 How	 damages	 are	 split	 and	 who	 negotiates	 for	 crop,	      •	 NCR-149,	Pasture	Rental	Arrangements	for	your	Farm
     permanent and seismic damages and sale of water for             •	 NCR-214,	 Rental	Agreements	 for	 Farm	 Buildings	 and	
     oil well drilling                                                  Livestock Facilities
                                                                     •	 NCR-215,	Farm	Machinery,	Equipment	or	Building	Lease	

                    The Crop Share Lease
Advantages to tenant:
 •	 Less	capital	may	be	required	as	compared	to	cash	renting.
 •	 Less	experienced	tenants	can	benefit	from	the	landowner’s	manage-
    rial input.
 •	 Risks	due	to	low	yield	and/or	price	shared	by	the	landowner.

Disadvantages to tenant:
 •	 Need	to	discuss	management	and	practices	with	landlord	on	a	con-
    tinuing basis.
 •	 Landlord	 managerial	 input	 presents	 more	 situations	 for	 possible	
    conflict between tenant and landlord.
 •	 Must	maintain	records	of	shared	expenses.
 •	 Must	share	gains	from	outstanding	management	and	benefits	of	above	
    average prices and/or yields in “good” years.

Advantages to landowners:
 •	 Receives	benefit	of	higher	than	average	prices	and/or	yields	in	“good”	
 •	 Land	and	improvements	are	more	likely	to	be	maintained	and	im-
    proved due to increased landowner involvement.
 •	 Relieved	of	many	operational	decisions	in	the	management	of	the	
 •	 Material	 participation	may	be	provided	more	easily	for	“use	value	
    estate purposes” than under cash leasing.
 •	 Passive	 income	 versus	 income	 when	 owner	 materially	

Disadvantages to landowner:
 •	 Need	to	discuss	management	and	practices	with	tenant	on	a	continu-
    ing basis.
 •	 Increased	risk	due	to	price	and	yield	variability	resulting	in	variable,	
    uncertain income.
 •	 Increased	responsibilities	and	possibilities	for	conflict	with	tenant.
 •	 Must	maintain	records	of	shared	expenses.
 •	 Capital	requirements	of	shared	input	production	costs.

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